Coming Up with Cash in a Pinch: Emergency Savings and Its Alternatives

June 2011

Stephanie Chase University of Wisconsin-Madison

Leah Gjertson University of Wisconsin-Madison

J. Michael Collins University of Wisconsin-Madison

Center for Financial Security Sterling Hall Mailroom B605 475 North Charter Street Madison, WI 53706 (608) 262-6766 [email protected] http://cfs.wisc.edu/

This research was supported by MDRC. The authors are grateful for feedback from Caroline Schultz, MDRC and Pamela Chan, New America Foundation who so generously shared their time and insights. The authors would also like to acknowledge both the Charles Stewart Mott Foundation and the Rockefeller Foundation for their support of the AutoSave Program. The opinions and conclusions expressed are solely those of the authors and do not represent the views of the New America Foundation, MDRC, or the Center for Financial Security at the University of Wisconsin-Madison.

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Coming Up with Cash in a Pinch: Emergency Savings and Its Alternatives

Much of the current discussion over the low personal savings rates of people in the U.S. is related to savings for retirement. While the concerns of how households will manage their finances in retirement remains a policy and research issue worthy of further attention, the debate over savings in that context may overshadow the important issue of the savings that people use in response to the unexpected expense. This savings, which we refer to as emergency savings, serves as a form of insurance against non-routine expenditures such as a car repair or unforeseen medical expense. Failing to adequately save is a common occurrence, especially for low and moderate income households. Without easy access to liquid savings, people to turn to other alternatives; including short-term credit, friends and family and potentially even public subsidy programs. People may fail to save for an emergency because they lack financial knowledge, fail to adequately assess the risk of an emergency or simply because they procrastinate. Other barriers to saving include asset tests in public benefit programs as well as a lack of access to useful savings account products. Ultimately people without emergency savings will turn to alternatives when they need immediate liquid financial resources. This paper reviews over 80 articles addressing the issue of savings and alternative mechanisms of liquidity for households. A number of articles address savings models or general theories of savings; far fewer focus on emergency savings and expenditure shocks, indicating an opportunity for future research. There is also a great deal of research about payday lending and other alternative credit mechanisms for consumers. A number of these studies address the need for low cost alternative credit for consumers without available emergency savings. The studies that included race, income or education as explanatory variables generally found that savings levels are lower for lower-income, minority and less-educated households. The incidence of expenditure shocks is not well studied, but at least two studies concluded that lower-income households are not as well prepared to manage a short-term demand for cash as higher-income households. Many studies do not favor the use of alternative credit and liquidity mechanisms, such as payday loans or pawnshop loans. The costs of these types of financial products may appear to be high compared to more traditional savings or checking accounts. Yet the continued demand for these products suggests an underlying need for liquidity that consumers of these products are trying to meet. Behavioral economists and psychologists suggest a variety of reasons that cause households to inadequately save for future liquidity shortfalls, including the inability to forecast future earnings or economic circumstances accurately. Additionally, households may underestimate the probability of a future expense coming in the near term, or even procrastinate and defer the act of saving repeatedly to the future. Given these behaviors, the need for liquidity, and the costs of potentially not being able to come up with funds to meet short-term emergency needs, future research could take a more holistic view of the costs and benefits of various forms of liquidity—ranging from cash, savings, credit and informal mechanisms.

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The Need for Cash: Liquidity When the family car needs a repair, the head of the household loses his or her job, or an individual has an unexpected medical expense, the family budget must respond to this income or expenditure shock. Ideally, families should set aside some precautionary savings in anticipation of job loss or other income shocks and emergency savings for unexpected expenditures such as a medical expense or a car break down. If households are living beyond their means there may be nothing left to set aside. For example, in 2003 a family at the 10th percentile of income had an income of $425 per month, just over $5,000 per year, and an annual expenditure of $6,600 (Meyer & Sullivan, 2003). Low-income households perceive their typical emergency savings as about $1,500 annually, but report usually spending $2,000 every year on these needs (Brobeck, 2008). When a family faces an emergency that requires immediate resources, they might dip into available savings, but in many cases, families do not have accessible liquid assets. If a family does not have access to accessible liquid assets, they might delay paying a bill, sell possessions, or seek a formal or informal loan. Emergency savings is different from Emergency Savings & Precautionary Savings Neither of these topics has been clearly defined in precautionary savings although the mechanisms the existing literature. In this paper, we use the for saving (or not saving) are probably quite terms for distinct purposes. similar. This paper focuses on emergency  Emergency savings is used in response to expenditure shocks such as a car savings as an area in need of research that can repair or medical expense be informed by what is already known about  Precautionary savings is used in response to income shocks such as a precautionary savings. Precautionary savings pay cut or job loss refers to a form of savings undertaken by people who expect some probability of having an income shortfall in the future. This might be due to predicted job losses or just variability in income. These income shocks are widely studied and important to understand (Wang, 2009). Expenditure shocks that require emergency savings in the form of liquid assets are less well studied. These shocks may be smaller in magnitude and in many cases predictable. Examples of predictable ―lumpy‖ expenditures include car repairs, seasonal heating bills, school supplies or clothing for children, or home/appliance maintenance. These are costs that most households will incur, although the exact timing may not be predicted. Other expenditure shocks are less predictable, such as medical expenses not covered by insurance, changes in family size/status, and support for relatives or moving. Depending on the household’s economic status any of these could be considered an emergency situation. Some expenses shocks are covered by property or causality insurance, but the types of expenses described above are not typically covered by insurance products available in the current market. Another way to describe this situation is that low and moderate income families often have a lack of financial slack (Mullainathan & Shafir, 2009). If a wealthier person and a poorer person face equal value financial shocks and cut back the same amount on consumption, the wealthier person is cutting back on their lower marginal utility consumption. In other words, in a financially difficult situation, a wealthier person can cut back on extra expenses, but a poor person must cut back on essential expenses.

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The demand for alternative financial products has grown in the last several decades due in part to the decline in the U.S. savings rate and recent financial crisis. Alternative credit products provide a source of liquidity for those without sufficient liquid resources. The growth of so called ―fringe‖ financial products in is part due to demand for liquidity. The savings rate in the U.S. has declined for a number of reasons (Maki & Palumbo, 2001).Younger generations are increasingly marked by low savings rates and higher levels of consumption relative to prior cohorts (Parker, 2000). Native born U.S. citizens have greater liquidity than immigrant populations in the U.S. (Amuedo-Dorantes & Pozo, 2002). In general low-income people have low savings rates (Browning & Lusardi, 1996). Low-wealth households expend proportionally more of their budget than higher-wealth households to maintain basic consumption of food, shelter and necessities, leaving little for savings (Scholz, Seshadri, & Khitatrakun, 2006). The lack of savings means that individuals must turn to other mechanisms to get money in times of emergency. The Great Recession of 2008-2010 was hard on balance sheets of U.S. households. In a survey of responses to the recession, 70 percent of families used money from savings that was set aside for retirement or education to pay current obligations and meet basic needs (Borie- Holtz, Horn, & Zukin, 2010). Figure 1 shows data on net worth by household income level. Households in the lowest income quintile had $10,100 in net worth in 2007 and then only $7,200 by 2009. While all income groups experienced a drop during this period, the net worth of the lowest income households was already so low that a modest drop, relative to where they started, has significant implications for those households.

[FIGURE 1]

Given the relatively low levels of net worth, it is important to understand the composition of this wealth. Table 1 shows that transaction accounts (i.e. checking and savings accounts with a bank or credit union) are widely held. Although researchers and practitioners tend to think of checking accounts as transaction accounts, and traditional savings accounts as tools for short-term and accessible saving, many consumers may not use the accounts in this way. For example, some consumers may keep a small buffer of extra funds in their checking account instead of a traditional savings account.

[TABLE 1]

Figure 2 shows data from the FINRA Financial Capability survey using the state samples weighted for the U.S. population. The survey examines unexpected income drops and the frequency households have emergency savings but does not explore emergency expenditure shocks. The data show that more than half of families with incomes under $15,000 experienced a drop in income in the last 12 months and that only 20 percent of these families have three months emergency funds. Lower income families are also asset poor, meaning that they have little ability to weather economic, income, or expenditure shocks. Conversely, among the highest income

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group less than 25 percent experienced an income drop and more than 75 percent have three months of emergency funds.

[FIGURE 2]

Using published tables of the national sample of the FINRA survey, Figure 3 displays the use of checking and savings accounts by income. These data show whether the respondent had a savings or checking account. Especially for the lowest income category with incomes under $25,000, less than two-thirds had a checking account and only 43 percent had a savings account. Just over 81 percent of the middle income group ($25,000-75,000) and 94 percent of the highest income group ($75,000 or more) reported having a savings account. People might keep emergency savings in either type of account, or even a different form of liquid instrument such as cash. But not having a traditional account is likely indicative of differences in access to liquidity in an emergency.

[FIGURE 3]

Figure 4 also uses published tabulations of the FINRA national survey by income category, but the questions summarized in this table are of the use of four alternative financial instruments that someone might turn to in order to pay for an emergency expense. These include an automobile title loan (or auto pawn), payday loan, tax refund anticipation loan and a pawn shop loan. These are asked as yes or no questions about any use of these loan products in the last 5 years. Given the design of this question, these results may not be comparable to other studies but nonetheless provide a general comparison of use of these loans by income level. Auto title loans are among the least used, although the data suggest an unexpected pattern of more likely use among people with currently higher incomes. In contrast, the other loans are less likely to be used by respondents with higher current incomes. Pawn shop loans are the most common for low-income people surveyed, with 16 percent reporting having used a pawn loan in the last 5 years. A slightly smaller 12 percent of the lowest income group report using a tax refund loan and 6 percent a payday loan. These products are not as large as the checking/savings market but do appear to be used more often in general among lower-income groups.

[FIGURE 4]

Another more recent survey focused specifically on how people cope with financial shocks. Lusardi, Schneider, and Tufano (2011) examined household financial fragility in the U.S. using the 2009 TNS Global Economic Crisis survey. The authors looked at the ability of U.S. households to come up with $2,000 in 30 days. Over half of the survey respondents said that they would be unable to cope with that amount of financial shock and 28 percent ―certainly unable‖ to cope. Individuals with less income and education reported being were less able to

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cope. African Americans, Hispanics and women all reported being less likely to be able to cope with a financial shock than the average respondent. The most commonly cited mechanisms included drawing from savings (62 percent), relying on family and friends (34 percent), mainstream credit such as a credit card (31 percent), selling possessions (19 percent), or increasing working hours or getting another job (23 percent).

What Explains Savings Behavior? Much of the literature in economics regarding household savings levels emphasizes the importance of long-term savings for goals including home ownership, education, and most prominently, retirement. Short-term needs or emergency situations are less studied. Theory and research from economics and social psychology provide insight into factors that influence savings behavior. Relevant concepts from these fields include financial slack, financial knowledge/literacy, self-control and procrastination. A data comparison of financial behaviors and a test of financial knowledge suggest that behavior and knowledge are closely linked (Hilgert, Hogarth, & Beverly, 2003). Results indicate that lower scoring respondents on financial knowledge tests engage in less saving and are less likely to pay bills on time. However, the authors point out that engaging in regular savings may be the source of financial knowledge rather than the result of it. Another study linked survey data with credit information and concluded that levels of objective and subjective knowledge about financial issues influence savings and credit use behaviors (Courchane & Zorn, 2005). Measures of financial knowledge tend to be highest for more-educated consumers and lower for lower-income consumers (Agnew & Szykman, 2005; Bernheim, 1998; Lusardi & Mitchell, 2006; Mandell, 2004; Bucks & Pence, 2006). Financial knowledge alone does not explain saving behaviors as even those with strong financial knowledge and an intention to save may fail set aside funds due to other behavioral impediments. Understanding procrastination or weak self-control has move beyond traditional economic theories to psychology. One informative concept has been referred to as financial slack by Gal Zauberman and John Lynch, two social psychologists. When money is tight, a consumer has little slack. Borrow money from the future, provides more slack today, at the expense of facing tighter slack in the future. People often discount how hard this future lack of slack will be and expect slack to be greater in the future than in the present. For example, at least one study suggests that low-income people may fail to adequately anticipate expenditure shocks. Brobeck found that among the lowest income quintile, households perceive their annual emergency savings needs at about $1,500, yet these households typically spend around $2,000 annually on emergencies (2008). Less than half of the households studied had a savings account and less than half with a savings account had emergency savings of at least $500. Further, behavioral economics emphasizes that people are poor predictors of their future state of mind. Thibos (2010) examined the issue of how people respond to financial shocks when they do occur. Thibos identified several types of shocks, including temporary or permanent reductions in income, retirement, property loss, natural disasters and, notably, expense shocks. People facing these shocks have few options: spend savings, use credit and/or economize. In order to

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utilize savings, the family had to have been spending/consuming less than total earnings before the financial shock. To utilize credit, a family is committing to spend/consume less after the shock in order to pay off the debt (Thibos, 2010, p. 9). Of course saving before a negative shock is only feasible if a household has resources available. There is a strong positive relationship between income and the amount that a household or family saves overall (Browning & Lusardi, 1996). Since all households might expect to face an income or expenditure shock it seems reasonable that all households would accumulate some savings for these needs. But like all forms of savings, precautionary saving levels rise with income (Guiso, Jappelli, & Terlizzese, 1992). Not having a savings account is one indicator of a lack of preparedness for a financial emergency. Fellowes and Mabanta report that about 12 million households in the U.S. lack a checking account (2008). The authors also found there are over 26,000 non-bank businesses that provide check-cashing services, almost 23,000 payday lenders, and almost 10,400 pawnshops (compared to 107,941 traditional bank or credit union branches). Areas with high proportions of minorities and foreign-born households have financial institutions (Joassart-Marcelli & Stephens, 2010). Nearly half of immigrant workers in one study were unbanked (Fine, Leimbach, & Jacob, 2006). Ryan, Osaki, and colleagues find that disproportionate share of the unbanked are from low-income and minority households (2009). The authors also estimate almost 26 percent of U.S. households are either unbanked or underbanked and households earning below $30,000 annually account for at 71 percent of all unbanked households. The literature does not support an explicit link between use of mainstream banking and the accumulation of savings, however. Nevertheless it seems likely problems in the market for checking and savings account products explain at least some consumers’ decisions to forgo these banking products. Lusardi (1998) uses data from the Health and Retirement Study (HRS) to examine how households might save to insure against unexpected income shocks--that is save as a precaution in case of a drop in income. Lusardi notes that estimating a precautionary saving model is complex: it requires detailed information about current net wealth, lifetime income, spending and the relative risk of an income shortfall. Lusardi finds that people who seem to face a higher risk of an income shock do save more. But precautionary saving is not particularly large relative to overall wealth. Merrigan and Normandin (1996) examine precautionary saving motivations in the United Kingdom using the Family Expenditure Survey. The authors also found that greater income uncertainty leads to larger current saving. Skinner (1988) provides another model of precautionary savings, suggesting that since the fluctuation in any one year's earnings is typically a small fraction of lifetime income, precautionary savings is not a major driver of savings overall. Only an expected permanent change in future earnings spurs savings. Skinner points to evidence of individuals in occupations with unstable incomes, including sales and self- employment, actually saving significantly less than average. Carroll and Samwick (1998) suggest quite the opposite. The authors simulated what households would save if they faced only minimal risk of an income shock. The authors found that for households under age 50 precautionary savings is in fact a major savings motive. If households could avoid any income shock they would reduce their net worth (aside from housing and business equity) by 50 percent.

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No longer needing liquidity, households would also reduce very liquid accounts (e.g. savings accounts) and shift to less liquid investments (e.g. real estate). Wilson (1998) estimated that if 15 percent of quarterly income is at risk of dropping, precautionary savings might be 5 to 10 percent of total saving. When twice as much income--say 30 percent of income--is at risk, precautionary savings also doubled to 9 to 21 percent of total saving. Households respond by increasing savings as the risk of a shock rises, consistent with precautionary savings. Uncertainty is also an important component in the demand for health care goods and services (Nocetti & Smith, 2010). Feigenbaum (2008) examined the impact of an expenditure shock such as medical expenses. If an individual receives information about likely medical expenses that will occur at the end of his or her life, this information will have a significant impact on the person’s precautionary savings and consumption over his or her lifecycle.

Saving and Asset Building The accumulation of savings or assets allows the current storage resources for future consumption. More than just an emergency fund, having assets can become a source of economic and social development for families (M. Sherraden & Sherraden, 1991). Individual development accounts (IDAs) are matched savings accounts that were developed to address some of the institutional barriers to savings. Typically the use of account funds is restricted to education, home purchase and repair, and to support microenterprise. One recent study examined use of an IDA program adapted for survivors of domestic violence (Sanders, 2010). The program expanded the allowable use of matched funds to include the purchase of a reliable vehicle and emergency expenses. Most of the women participating in the program lived at or below 150 percent of the poverty line and had an average savings of $87 per month. Sanders found that about two-thirds of women in the program reached their savings goals. Importantly this IDA program, unlike prior models, explicitly allowed for and encouraged savings in the IDA for emergency expenses. A potential area for future research is the evaluation of this model with other populations.

What Are the Alternatives to Savings Mechanisms? There are a variety of mechanisms that consumers use when they face short-term liquidity emergencies. A person might ask a friend or family member to lend money, delay or skip the payment, use an alternative financial service such as a payday lender, or tap longer term savings from a retirement or life insurance account. McKernan, Ratcliffe, and Kuehn (2010), using data from the FINRA National Financial Capability Survey, found that between 6 and 13 percent of U.S. families used an alternative financial service such as a payday loan, pawnshop, refund anticipation loan or auto title loan. The source of alternative credit used by the consumer may vary based on the amount the consumer is borrowing or borrows on a regular basis (Schneider & Koide, 2010). Table 2 discusses and the benefits and problems associated with a variety of possible alternative mechanisms. Liquidity mechanisms include informal lending, making a late payment or skipping a payment, payday lending, pawnshops, auto title lending,

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obtaining a refund anticipation loan, using a credit card, drawing from a retirement account, and drawing from life insurance. Each is described in more detail below.

[TABLE 2]

Informal Lending. Informal lenders can be a community connection or a family member. This lending is most commonly used for bigger transactions such as purchasing a home or starting a business. It is less often used in an emergency. Most of the literature related to informal lenders involves lending systems in developing nations (Aleem, 1990). Mansuri examined informal lending models and found that informal lenders have an information or enforcement advantage in dealing with borrowers (2007). Formal lenders have access to capital on preferential terms but cannot observe borrower output without undertaking a costly audit. Conlin examined peer to peer micro-lending programs in the U.S. and Canada (1999). He concluded that when groups of friends and family members participated in the program together, overhead costs could be reduced and people were more likely to stick with the program and repay the loan. Peer pressure had a positive effect in most situations. Another study examined a micro-lending model on Pine Ridge Indian Reservation in South Dakota (Pickering & Mushinski, 2001). The lending model was not particularly successful because of social and cultural factors and experienced low repayment rates. Pickering and Mushinski found that the micro-credit group structure put too much pressure on individuals, and they argued that including family units could have a positive impact.

Skipping Another Payment. One simple way for an individual to deal with an unexpected expense is to skip a payment or a bill for another item. This behavior often results in additional fees, may result in service or utility shut-offs, and will undermine an individual’s credit history. Of U.S. consumers, about 32 percent pay fees every month related to poor management of credit cards and other bills (Thibos, 2010).

Payday Lenders. Payday loans are small single-payment loans, often for a short time period such as two weeks (Elliehausen & Lawrence, 2001). To initiate a loan, a customer writes a personal check for the loan amount plus a finance charge and the payday lender defers cashing the check until the customer’s next payday. On or before the next payday, the customer can either pay the loan amount plus the finance charge or the lender cashes the check. Additionally, a customer can extend the loan by paying the finance charge and then writing a new check. Loans are typically between $100 and $500. Finance charges usually range from $15 to $20 per every $100 of the loan. This translates into APRs of over 300 percent (Flannery & Samolyk, 2005). Currently, payday lending is prohibited in 13 states and 33 states have some cap on the APR charged for the loans (Pindus, Kuehn, & Brash, 2010). Payday customers tend to have lower incomes, less wealth, fewer assets and less debt than non payday users based on one study (Logan & Weller, 2009). About 29 percent of

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borrowers reported that the reason they borrowed was for an emergency and 21 percent cited a basic consumption need such as paying for gas or a car repair. Consumers who use payday lenders often obtain multiple loans in a given year. (J. P. Caskey, 2005). Chessin (2005) found the higher the initial loan amount, the more likely the loan is to be either renewed or rolled over. Studies on the impact of payday loans report mixed results. Carrell and Zinman (2008) examined the impact of these loans on service members in the U.S. Air Force, finding a association with being ineligible to reenlist and the presence of an unfavorable information file in the individual’s personnel file. Skiba and Tobacman (2008) found using payday loans increases the chance of filing for Chapter 13 bankruptcy. Wilson, Findlay and colleagues (2010) found that payday loans could improve financial outcomes, based on lab experiments with students designed to mimic a scenario that consumers who use payday lenders might encounter. Having payday loans as an available option increases the probability of being able to pay bills; but most participants were benefited by their existence. Efforts to develop payday lending alternatives in North Carolina are important to highlight because the state outlawed payday lending in 2006. Manturuk and Quercia (Manturuk & Quercia, 2007) surveyed lower income individuals that had previously used payday lending, finding 68 percent said that the elimination of payday lending had no impact on their household. The authors also surveyed former payday loan users about what those families did during their most recent financial crisis. Survey respondents said that they paid late or did not pay, relied on family or friends, or used savings or a credit card.

Pawnshops. The existence of pawnshops dates back to the fifteenth century, when Franciscan priests offered low-cost collateralized loans (J. Caskey, 1994). Pawnshops have existed in America since colonization and their use grew until the 1930s. Pawnshop loans declined from the 1930s through the early 1970s, but began to grow again starting in the 1970s. Industry growth has been stagnant since the 1990s and some pawnshops began to expand into other alternative financial products including payday loans in the last 10 years (J. P. Caskey, 2005). There are around 11,600 pawnshops nationally. In terms of regulation, 40 states have a monthly interest rate cap for pawnshops and 10 states have a return requirement (Pindus, et al., 2010). Pawnshop customers receive a loan when they bring in a personal property item, such as a watch. When the customer returns to a pawnshop, they must pay the loan amount, plus a finance charge. For example, if an individual were to receive a $50 loan in return for a pawned item and repay with a finance charge of $9, their APR would be 219 percent (Johnson & Johnson, 1998). About two-thirds of items were redeemed by customers, and this is what pawnshop owners often prefer because it means that the customer is likely to return for additional loans. Johnson and Johnson note that consumers from any economic status are unlikely to obtain small loans, averaging $75, from any financial institution. Pawnbrokers offer a service that would be expensive and time consuming for more traditional institutions. Customers of pawnshops come from a variety of socioeconomic groups but the majority of customers come from low or moderate income homes, and have a high school education or less (J. Caskey, 1994). Johnson and Johnson report that pawnshop customers are less likely to

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own a home (1998). Among users of alternative financial services, pawnshop users tend to have the lowest incomes (McKernan, et al., 2010). Only about 57.6 percent of pawnshop customers have a checking account (Johnson & Johnson, 1998). Customers borrowing from a pawnshop cited various reasons for borrowing: 32 percent said they had pressing bills, 32 percent said they had personal reasons for borrowing, and 13.5 percent said they had car expenses. Of individuals who were active borrowers from pawnshops, 45 percent said that they had borrowed once or twice in the last 12 months.

Auto Title Loans. Studies about the auto title lending industry have focused on individual states that allow the practice. Auto title loans are prohibited in 27 states and 13 states have an APR cap (Pindus, et al., 2010). A survey by the Consumer Federation of America found that the average APR charged by auto title lenders with physical locations in 11 states was 300 percent (Fox & Guy, 2005). This study also surveyed 17 online title lenders and found some charging APRs as high as 650 percent. A study by McKernan, Ratcliffe and Kuehn found that 17 percent of auto title lending users had incomes of $75,000 or above and are more likely than users of other alternative financial products to have a bank account (2010). More in depth studies of title lending have been completed in Illinois and Tennessee. In Illinois in 2005, there were 63 auto title lending companies operating through 260 locations across the state (Feltner, 2007). Feltner found that the median loan principle was $1,500, with an average finance charge of just over $1,500. The average term for an auto title loan in Illinois is 209 days and the average APR is 256 percent. On average, cars used as collateral for auto title loans were about 11 years old with odometers reading above 90,000 miles. In Tennessee, the state Department of Financial Institutions complies an annual report on auto title lending (2010). In 2008, over 161,000 new consumer title agreements were transacted and generated over $103,000 in loan volume. Of new agreements, 60 percent were for $500 or less, 86 percent were for $1000 or less. The maximum loan amount in Tennessee is $2,500 and the maximum APR is 264 percent. The Department found a 16 percent decrease in new title loans from 2006 to 2008. Auto title loans are more likely to be made to male customers living in moderate to middle income communities (Feltner, 2007). Approximately 77 percent of borrowers live in middle or moderate income communities. About 66 percent of individuals obtaining title loans live in minority communities. Feltner also found that 18 percent of auto title loans in default resulted in the borrower losing their vehicle, which may be the borrower’s transportation to work.

Refund Anticipation Loans. Refund anticipation loans (RALs) are short-term loans based on a taxpayer’s expected income tax refund (Treasury Inspector General for Tax Administration, 2008). The use of RALs has declined recently in part due to legislation at the state level and a change in IRS practice. Bank lenders issue RALs, but tax preparers facilitate the transactions between banks and users of RALs. In 2008, almost 10 million taxpayers borrowed against part or all of their tax refund to obtain a RAL. One study of the Detroit area found that RALs were the

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most common form of short term credit used (Barr, Dokko, & Keys, 2009). Consumers paid about $833 million in RAL fees in 2007 for almost 10 million loans (Wu & Fox, 2009). One Midwest study found that user paid an average of $177 which equaled about 8 percent of their refund (Barr & Dokko, 2008). The APRs associated with RALs frequently range from 50 percent to 500 percent. Federal legislation prohibits offering RALs to active military personnel and their spouses or dependents with an APR of greater than 36 percent (Treasury Inspector General for Tax Administration, 2008). Aside from the federal cap for military personnel, 3 states have APR caps for RALs, 17 states have disclosure requirements and two states have right to rescind provisions (Pindus, et al., 2010). Research indicates the most important characteristics influencing whether or not individuals used a RAL include lower income, young adulthood, single head of household filing status, receipt of the EITC, and use of a paid preparer (Theodos, Brash et al., 2010; McKernan, et al., 2010). Other surveys support the idea that tax preparers can have an important impact on the products that consumers use (Duflo, Gale, Liebman, Orszag, & Saez, 2006). A study conducted in the Detroit metro area found that almost 40 percent of low and moderate income households that used a paid tax preparer took out an RAL (Barr & Dokko, 2008). RALs are used at higher rates in the southern U.S. and on Indian reservations in the Midwest and Great Plains than in other parts of the country. The First Nations Development Institute studied the use of RALs among EITC filers and found a positive correlation between an increase in the number of Native Americans in a county and the use of RALs among EITC tax filers (2009). They also found that on average, an EITC filer pays $250 for tax preparation services and a RAL. Industry representatives report that the most frequently cited reasons for getting an RAL included needing money to alleviate post-holiday financial strain, general financial strain and unexpected expenses, lack of funds for tax preparation costs, lack of a bank account, mistrust of conventional financial institutions and being a military family. Common uses of RAL funds include paying regular bills, car repairs or home expenses, or paying off debt; a small minority report putting the money into savings (Bertrand & Morse, 2009; Barr & Dokko, 2008; Treasury Inspector General for Tax Administration, 2008). A survey of RAL users suggests that there may be a limited understanding of the product at the time the loan is taken out. The survey found that while 85 percent of RAL users said that their tax preparer made it clear that the product was a loan and 88 percent said that the preparer explained the fees, only 34 percent had the loan interest rates explained to them (Treasury Inspector General for Tax Administration, 2008). The use of RALs has climbed in the mid-2000s but has been declining in recent years (Berube & Kornblatt, 2005). In April 2010, J.P. Morgan Chase pulled out of the lending market for RALs (Douglas, 2011). Then in August 2010 the IRS announced that it would no longer provide a credit check on taxpayers for banks or tax preparers. Additionally, HSBC terminated its lending agreement with H&R Block, which caused H&R Block exit the RAL market. In 2011, only three community banks still originate RALs, Republic Bank & Trust and River City Bank in Louisville, Kentucky, and Ohio Valley Bank in Gallipolis, Ohio; two of which announced in February 2011 that they will leave the RAL market at the end of this tax season.

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Credit Cards. Soman and Cheema examine the impact of credit on spending decisions (2002). The authors conducted five separate studies. In the first study, the authors manipulate credit limit and quality and pose subjects with a hypothetical purchase opportunity. They found that credit limit impacted the propensity to spend, but only when the credibility was high. In the second experimental study, they replicated the above findings even when subjects were given information about expected future salaries. The authors also show that the credit limit influences the subjects' expectation of future earnings potential. In the third study, the authors show that the mere availability (and increase) of current liquidity cannot explain their findings. In the fourth study, they survey consumers, measure a number of demographic characteristics and also ask them for their propensity to spend in a given purchase situation. In the fifth study the authors use the Survey of Consumer Finances (SCF) dataset. Results from both studies four and five provide further support for the proposed framework that credit limits influence spending to a greater extent for consumers with lower credibility: younger consumers and less-educated consumers. About two-thirds of Americans in one survey reported having a credit card (Gross & Souleles, 2002). Gross and Souleles found that of households that have a credit card, 56 percent are liquidity constrained. Further, the authors found that increasing those individuals credit limits generates an immediate and significant rise in debt and that the marginal propensity to consume is much larger for people who begin near their credit limit. Agarwal, Skiba and Tobacman used a matched sample of payday lending customers that also had credit cards from a particular lender (2009). They found that most people in the sample had credit card liquidity that exceeds the size of a typical payday loan. Another study found that many people prefer to become delinquent on mortgages, rather than delinquent on credit card payments (Cohen-Cole & Morse, 2010). The authors found an increase of 127 percent of this behavior between June 2006 and December 2007. The decision to pay a credit card bill rather than a mortgage bill has the negative externality of higher foreclosures.

Retirement/Pension Loans or Liquidation. Early withdrawals from retirement or pension plans are another way that individuals respond to income shocks. Looking at 10 years of tax returns, Amromin and Smith find that early withdrawals are significantly more likely to occur in households with job loss, income shocks, divorce, home purchases and low levels of non- retirement financial wealth (2003). These indicators increase the likelihood of early withdrawals by 3 to 10 percentage points each. They also find that households with low non-retirement financial wealth are significantly more likely than other households use their retirement account funds in response to such shocks. They conclude that a significant portion of early withdrawals from retirement accounts reflects consumption-smoothing behavior by liquidity-constrained households who experience financial shocks. A 2009 GAO Report examines hardship withdraws from retirement accounts (U.S. Government Accountability Office). The study reports that simulations of the long-run effects of withdraws have the greatest impact younger participants since these savers will miss out on

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compounded earnings, as well as lower-income earners. Larger withdrawal amounts taken earlier have the most negative proportional impact.

Life Insurance Draws. Life insurance policy loans can be another source of emergency funds. At the end of 2007, there were $113.9 billion in outstanding life insurance policy loans in the U.S. (Liebenberg, Carson, & Hoyt, 2010). When a person draws a loan against their life insurance policy, that loan accrues interest like any other loan, but also reduces the amount of the death benefit available through the insurance policy. Gutter and Hatcher (2008) examine racial differences in life insurance demand. They use Survey of Consumer Finances data from 2004 to look at the proportion of households with life insurance policies and how much insurance is purchased. The authors found that whites had higher levels of net worth, more homeownership and greater usage of life insurance. There was not a significant difference between whites and blacks in terms of having whole life policies, but whites have more term insurance. Whites had a greater proportion of ―human capital‖ insured—40 percent compared to 18 percent for blacks. Low and moderate income families are also less likely to have access to group life insurance through their workplace (Thibos, 2010). Bernheim, Carman, Gokhale, and Kotilkoff (2001) found that having life insurance is not correlated with financial vulnerability over an individual’s lifecycle. They also found the impact of having life insurance among at-risk households is modest, and there are widely spread vulnerabilities when families do not have life insurance, particularly among younger couples or families. The authors reported that about two-thirds of poverty among surviving women and more than one-third of poverty among surviving men results from a failure to adequately insure for survivors. For any level of financial vulnerability, couples provide significantly more protection for wives than for husbands. Use of life insurance policy loans was more prevalent in the 1970s. Carson and Hoyt (1992) found that a 1980 model act proposed by the National Association of Insurance Commissioners to address interest rates for policy loans had some impact on the use of policy loans. A version of this bill was adopted in all 50 states by the early 1990s allowing variable policy loan interest rates, and use of policy loans has declined. However, the authors noted that there were a number of other variables that also related to the demand for life insurance including market interest rates, personal income, the rate of unemployment, and the costs of alternative sources of credit. Recently Liebenberg, Carson and Hoyt (2010) used data from the Survey of Consumer Finances (SCF) to examine life insurance policy loan demand. They found a significantly positive relationship between loan demand and recent expense or income shocks. Life insurance policy loans dramatically increased in the late 1960s when market interest rates were greater than policy loan rates. The authors used SCF panel data from 1983-1989, including around 720 households that were able to take loans against their life insurance policies. The authors found that when households needed emergency funds they are more likely consider alternative sources like policy loans. The authors found there was an increase in the use of policy loans after

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households experienced expense or income shocks. They also find that credit scores may be helpful in predicting loan demand.

[TABLE 3]

Synthesis of the Literature The Appendix table summarizes the key articles discussed in this paper. Over 80 papers address the issue of precautionary or emergency savings or an alternative mechanism of liquidity for households. Outside of the approximately 30 articles that discuss savings models or precautionary savings in general, only about five focus specifically on emergency savings for unexpected expenditure shocks. Almost 20 articles discuss payday lending, and nearly as many discuss other forms of alternative credit that households may use for short-term cash needs. Several of these studies link the need for alternative credit to lack of short-term savings. Most of the studies that included race, income or education as explanatory variables conclude that savings levels are lower for lower-income, minority and less-educated households. Other studies suggest income shocks are at least as likely if not more likely for these same populations. While the incidence of expenditure shocks is not well studied, it appears from at least two studies that lower-income households are less well prepared to manage a short-term demand for cash than higher income households. Many studies take a dim view of alternative means for households to raise liquidity in the short run, such as payday loans or pawnshop loans. The costs of such products appear to be high on an absolute level. Yet continued household demand for these products suggest an underlying need for liquidity that these markets are trying to access. Behavioral economics and psychology suggest that households may fail to adequately save for a rainy day due to forecasting errors, even beyond lacking financial resources. Households may underestimate the probability of a future expense coming in the near term, or even procrastinate and defer the act savings repeatedly to the future. Given these behaviors in the social and economic environment, there will continue to be a demand for liquidity to meet short-term emergency needs. There is a need for future research to take a more holistic view of household current and expected income and expenses and a fuller detailing of the costs and benefits associated with various forms of liquidity.

Conclusion Emergency savings and precautionary savings are important areas for further study. All people face some probability of having an income shortfall in the future, yet preparedness for this is uneven by demographic, racial and economic sub-groups. These income shocks are widely studied and perhaps better understood than expenditure shocks, especially for low-income populations. Households might need liquidity for a variety of reasons, precipitate tapping a savings account or an alternative mechanism such as a pay day loan. These expenditures might be ordinary, relatively fixed costs that the consumer simply failed to budget for correctly, perhaps overspending on some other aspects of the monthly budget. These expenditures might

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also have been somewhat predictable yet ―lumpy‖ costs such as car repairs, seasonal heating bills, or home/appliance maintenance. These are costs that most households will incur, although the exact timing may not be well predicted. Regardless if the cause was financial mismanagement or bad luck the household faces the same cash crunch and financial product alternatives. There are a variety of costs and benefits to the mechanisms that serve as alternatives to short term savings. People who do not have short term savings have little choice but to use alternatives when they face a liquidity emergency. Having a rainy day fund potentially extended the time a household can weather a negative financial shock, and perhaps also improved expenditures financial security and well being. Not having such support to backstop the household budget could mean people are more likely to turn to public programs or charity such as food support (SNAP) or a charitable food pantry. In the U.S. many workers are covered by unemployment insurance as a way to partially (and temporarily) insure against a drop in income due to job loss. While health insurance protects some from major health spending, a significant portion of the population is not well covered by insurance. Car or appliance repairs are not widely insured and extended warranties often are criticized for being overpriced. It seems that credible insurance products could be developed to insure against expenditure shocks. Of course public programs may actually inhibit lower-income households from building up an emergency savings account. Programs such as SNAP (depending on the state), SSI, Medicaid and TANF all contain forms of asset tests. Asset tests at initial application or for continued eligibility may signal to households that saving should be avoided. Even among people not in public programs, basic savings accounts can be costly. Minimum balances and other features might actually result in fees that rival some credit products. Moreover, traditional savings accounts may be both too easy to access and too hard. Too easy in the sense that people often realize their own self-control problems and favor accounts with limited access. Accessing the funds take some extra steps and will be noticed by someone external to the account holder. But beyond constraints to enhance self-control people also need to have accounts that can be accessed in a few days (or hours) when an emergency does occur. The product challenge is to develop a product or account that meets these needs at a low cost and that is accessible for people most in need.

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Table 1

Percent of Households by Income with Financial Asset or Debt, 2009

Any Cash Credit Transaction Certificates Savings Any Installment Financial value life card accounts of deposit bonds debt loans Asset insurance balances

Less than 20 83% 77% 9% 4% 15% 56% 28% 33% 20–39.9 94% 91% 14% 10% 22% 73% 38% 51% 40–59.9 97% 95% 14% 12% 22% 84% 51% 57% 60–79.9 100% 100% 19% 21% 26% 88% 57% 58% 80–89.9 100% 99% 21% 25% 32% 89% 52% 56% 90–100 100% 100% 26% 24% 41% 84% 32% 41%

Source: Survey of Consumer Finances (Bricker, Bucks, Kennickell, Mach &Moore, 2011) http://www.federalreserve.gov/pubs/feds/2011/201117/201117pap.pdf

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Table 2 Summary of Liquidity Mechanisms

Type Pro (+) Con (-) Checking Account Convenient Overdraft fees costly if withdraw more than account balance Savings Account Convenient Minimum balance required; limits on withdrawals A. Informal Lending Convenient; Underwriting and Relationship based Collections efficiencies B. Late or Skipped Convenient Undermines credit history; may Payment lose other accounts C. Payday Loan Convenient advance of short run Requires bank account; costly if income used repeatedly D. Pawnshop Can liquidate durable goods or May be costly; may lose personal property property E. Auto Title Loan Convert equity in auto to current May be costly; may lose vehicle consumption; Collateralized F. Refund Anticipation Can convert tax refund to Short term loan once per year; Loan consumption May be costly G. Credit Card Convenient; Terms vary; Qualifications standards vary H. Retirement/401(k) Low cost loan; May be significant Access varies; nonpayment Loan/ Liquidation assets carries tax penalty; Loss of retirement security I. Whole Life Insurance Low cost loan Access varies Cash Value Loan

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Table 3

Estimated Costs by Loan Type

Type Cost A. Informal Lending Social and monetary costs vary

B. Late or Skipped Payment $30 fee for any amount.

C. Payday Loan $20 fee for $100, two-week loan. Additional fees for rolling over the loan. D. Pawnshop $10 fee for $100 loan. Possibility of losing item if do not repay loan. E. Auto Title Loan $30 fee for every $100 of loan amount. Possibility of losing car if do not repay loan. F. Refund Anticipation Loan $65 fee for $3,300 average loan. RALs tend to be larger loan amounts. G. Credit Card $30 fee for any amount.

H. Retirement/401(k) Loan/Liquidation Fee is 10% of the amount withdrawn from the account. I. Whole Life Insurance Cash Value Loan Fees vary greatly between 5-12%.

*The costs noted above vary greatly depending on state laws. The costs above are averages or found in the literature.

Center for Financial Security 23

Figure 1 Median Net Worth 2007-2009 ($000)

2007 2009 $100.0 $95.4 $90.0

$80.0 $72.6 $70.0 $60.0 $50.0 $39.1 $40.0 $32.9 $30.0 $20.0 $10.1 $10.0 $7.2 $- Lowest quintile Second quintile Third quintile

Source: Survey of Consumer Finances (Bricker, Bucks, Kennickell, Mach &Moore, 2011) http://www.federalreserve.gov/pubs/feds/2011/201117/201117pap.pdf

Center for Financial Security 24

Figure 2 Emergency Funds and Drop in Income

Source: FINRA Financial Capability Survey, State Sample, National weights. Authors’ tabulations.

Center for Financial Security 25

Figure 3

Account Holding by Income, 2009

100% 95% 98% 94% 90% 81% 80%

70% 63% 60%

50% 43% Checking 40% Savings 30% 20% 10% 0% <$25K $25-75K $75K+

Source: FINRA Financial Capability Survey, National data, Published tables.

Figure 4

Use of the Following in the Past 5 Years, 2009

% Yes <$25K $25-75K $75K+ Auto title loan 5% 7% 10% Payday loan 6% 6% 2% Refund anticipation loan 12% 7% 3% Pawn shop 16% 7% 1% FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

Center for Financial Security 26

Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

Lifecycle Agarwal, 2007 The Age of Reason: Financial Bank data indicates that middle aged adults are able to borrow at lower interest rates and pay lower fees; this Driscoll, Gabaix, Decisions Over the Lifecycle is linked to level of experience and peaking analytic capability. &Laibson

Credit Cards Agarwal, Skiba, 2009 Payday Loans and Credit Cards: A matched sample of 3,090 payday borrowers with credit cards finds most borrowers have credit card liquidity & Tobacman New Liquidity and Credit Scoring that exceeds the size of the typical payday loan. Annual pecuniary costs of payday borrowing are larger than Puzzles? credit card costs.

Non- Aleem 1990 Imperfect Information, Screening, Qualitative study of farmers finds that borrowers perceive each lender to be offering a different product traditional and the Costs of Informal Lending- creating a downward-sloping demand curve, farmers seeking loans are not aware of the terms; and lenders Loans -A Study of a Rural Credit Market do not have any incentive to cut their interest rates to increase market share. in Pakistan

Pensions Amromin & 2003 What Explains Early Withdrawals Early (penalized) withdrawals are significantly more likely to occur in households with job loss, income shocks, Smith from Retirement Accounts? divorce, home purchases, and low levels of non-retirement financial wealth. These indicators increase the Evidence from a Panel of likelihood of early withdrawals by 3 to 10 percentage points each. Results also indicate that households with Taxpayers low non-retirement financial wealth are significantly more likely than other households use their retirement account funds in response to shocks.

General Amuedo- 2002 Precautionary Saving by Young Ten percent increase of income uncertainty for native born people increases their financial wealth to Dorantes, & Immigrants and Young Natives permanent income ratios by 19.6 percent. A 10 percent increase in income uncertainty for immigrants results Pozo in an increase in financial wealth to permanent income ratio by about 27.8 percent. Native born residents have greater liquidity than immigrants. Immigrants' patterns may be related to remittances to relatives in their home countries.

Individual Ashraf, Karlan, & 2006 Tying Odysseus to the Mast: Participants were offered a new savings account that restricted access to the deposits. Women with Development Yin Evidence from a Commitment hyperbolic time preferences preferred the product and average bank account savings increased 47 percent Accounts Savings Product in the Philippines after six months. After 12 months, average bank account savings increased 82 percent.

Unbanked Bachelder, 2008 Banks’ Efforts to Serve the Only 8 percent of surveyed banks offer IDAs; of those offering IDAs, 22 percent partner with other Alexander, Yu, Unbanked and Underbanked organizations. About 97 percent of banks can originate an unsecured personal loan in less than 48 hours and Bellows, 69 percent of banks offer unsecured personal loan amounts for up to $5,000. Less than 6 percent of banks Stanton, Rumble provide an advance on funds. Only 25 percent of these banks offer secured credit cards to customers who do & Barr not qualify for a traditional credit card.

Payday Bair 2005 Low-Cost Payday Loans: Overdraft fees are the substitute or alternative to payday loans. The APR for payday loans rises with the loan Opportunities and Obstacles amount, but overdraft fees usually remain constant. Case studies show banks could offer lower cost payday loan alternatives such as a checking account linked to a revolving line of credit.

Center for Financial Security 27

Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

Refund Barr & Dokko 2008 Third-Party Tax Administration: The Detroit Area Household Financial Services study found that 82 percent of income tax filers received a Anticipation The Case of Low-and Moderate- refund, and the average size was around $2,000. About 66 percent of low income filers used a paid preparer Loans Income Households and 38 percent of those took out a refund anticipation loan (RAL). RAL users paid $177 or about 8 percent of their refund in fees. About 82 percent used the RAL to pay bills or other debt. More than 60 percent of unbanked households using a paid preparer took out a RAL.

Unbanked Barr, Dokko, & 2009 And Banking for All? Half of the households in the Detroit Area Household Financial Services study use short term credit products. Keys Refund anticipation loans (RALs) are the most common form of short-term borrowing (28 percent), followed by taking an overdraft from an account (20 percent). Pawnshops (11 percent) and credit card cash advances (8 percent) are other commonly used borrowing. Few respondents take out payday loans (3 percent). Because a bank account and proof of employment are required, most respondents may be too disadvantaged to qualify for such loans.

Life Bernheim, 2001 The Mismatch between Life Life insurance is not correlated with financial vulnerability over the lifecycle. The impact of insurance among Insurance Carman, Insurance Holdings and Financial at-risk households is modest, and substantial uninsured vulnerabilities are widespread, particularly among Gokhale, & Vulnerabilities: Evidence from the younger couples. Roughly two-thirds of poverty among surviving women and more than one-third of poverty Kotlikoff Survey of Consumer Finances among surviving men results from a failure to insure survivors against an undiminished living standard. There was evidence of a systematic gender bias: for any given level of financial vulnerability, couples provide significantly more protection for wives than for husbands.

Lifecycle Bertrand, Karlan, 2005 What's Psychology Worth? A Field Interventions appear to weaken the sensitivity to interest rates, especially when rates are high. The average Mullainathan, Experiment in the Consumer Credit effect of a psychological intervention was about equal to a one half percentage point change in the monthly Shafir, & Zinman Market interest rate. Interventions had similar effects across race, gender, education or income.

Payday Bertrand & 2009 What Do High-Interest Borrowers There were persistent declines in payday borrowing following the receipt of a tax refund. For a large sub- Morse Do with Their Tax Rebate? group the refund is used for regular monthly obligations, such as paying down late utility bills or making rent payments.

Refund Berube & 2005 Step in the Right Direction: Recent IRS data indicates the use of refund anticipation loans (RALs) climbed from 1999 to 2001, but declined in Anticipation Kornblatt Declines in Refund Loan Usage 2002 by 4.6 percent. RAL use declined in all regions of the U.S., but the decline was most dramatic in the Loans Among Low-Income Taxpayers Midwest.

Institutional Beverly, 2008 Determinants of Asset Holdings The policies, programs, products and services of financial institutions can shape access and information about Access Sherraden, assets and savings. Cramer, Shanks, Nam, & Zhan

Lifecycle Borie-Holtz, Van 2010 No End in Sight: The Agony of In a survey of responses to the recession, 70 percent used money from savings that was set aside for Horn, & Zukin Prolonged Unemployment retirement or education plans to meet current needs and 41 percent sold some of their possessions. About 56 percent of currently unemployed people borrowed money from family and friends and 45 percent have increased credit card debt. About 25 percent have missed a credit card payment, 24 percent have missed a mortgage or rent payment and 11 percent had to borrow money against their house or from a bank.

Center for Financial Security 28

Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

General Brobeck 2008 The Essential Role of Banks and Among lowest income quintile, households perceive their annual emergency needs at about $1,500 but they Credit Unions in Facilitating Lower- typically spend about $2,000 annually on emergency needs. Less than half of these households have a Income Household Saving for savings account and less than half say they have emergency savings of at least $500. Important factors for Emergencies low and middle income households to save include a competitive interest rate, aggressive marketing, regular automatic deposits, and affordable terms.

Lifecycle Browning & 1996 Household Saving: Micro Theories The distribution of savings across different income groups shows a strong positive relationship between Lusardi and Micro Facts income and saving. There has been a decline in the U.S. savings rate since the 1970s. The article contains a review of empirical studies about precautionary and life-cycle saving.

Payday Bucks, 2009 Changes in US Family Finances In 2008: 57 percent of families reported that they had saved in the last year, 31 percent of families reported Kennickell, from 2004 to 2007: Evidence from that they were unsure of what their income would be in the next year, 47 percent had installment debt and 46 Mach, & Moore the Survey of Consumer Finances percent had revolving balance on their credit cards. Payday loans were used for emergencies (35.9 percent), convenience (21.0 percent), the need to pay living expenses such as food, gas, car or medical expenses or rent (20.6 percent), or the need to pay other bills or loans (10.8 percent).

General Caballero 1990 Consumption Puzzles and Different models are used to examine precautionary savings. The relatively low real interest rate observed in Precautionary Savings the postwar U.S. data can be explained by the consumption path and precautionary savings.

Payday Carrell & Zinman 2008 In Harm's Way? Payday Loan Access to payday loans increases the likelihood that an U.S. Military airman is ineligible to reenlist by 3.9 Access & Military Personnel percent. Payday loan access significantly increases the likelihood that an airman is sanctioned for critically Performance poor readiness (as measured by the presence of an unfavorable information file in the persons personnel file) by 5.3 percent.

General Carroll & 1998 How Important is Precautionary In households younger than 50 years old, setting the uncertainty of every household to the smallest predicted Samwick Saving? uncertainty reduces total net worth of households by about 45 percent. It also reduces non-housing net worth by half and reduces holdings of very liquid assets by 32 percent.

Life Carson & Hoyt 1992 An Econometric Analysis of the Examination of how loan rates impact the use of life insurance policy loans. A literature review identified Insurance Demand for Life Insurance Policy variables that relate to the demand for life insurance policy loans include market interest rates, personal Loans income, the rate of unemployment, and the costs of alternative sources of credit. In 1980 a model bill was introduced by the National Association of Insurance Commissioners allowing variable policy loan interest rates. A version of this bill was adopted in all 50 states by the early 1990s and the use of policy loans has declined.

Pawnshops Caskey 1994 Fringe Banking: Check-cashing There has been growth in fringe banking services and as the credit risk of families has increased, traditional Outlets, Pawnshops, and the Poor lending options have become less available. In many urban areas, banks closed branches in disproportionately low-income and minority neighborhoods. Check cashing customers report favoring location and hours that are more convenient than banks.

Center for Financial Security 29

Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

Payday Caskey 2005 Fringe Banking and the Rise of State data indicates 26 percent of individuals borrowed 1 to 5 loans, 24.5 percent borrowed between 6 and 10 Payday Lending loans, over 31 percent borrowed between 11 and 20 loans, and 18 percent borrowed more than 20 loans in the previous year. Additionally, many pawn broking outlets offer payday loans.

Payday Chessin 2005 Borrowing from Peter to Pay Paul: The average payday borrower in Colorado state is a 36 year old single woman, making about $2,300 per A Statistical Analysis of Colorado's month as a laborer or office worker. The average payday loan principle is about $285, the average finance Deferred Deposit Loan Act charge is $50, and the average loan term is about 16 days. There is a correlation between the loan amount and the percentage of consecutive loans--the higher the initial loan amount, the more likely the loan is to be either renewed or rolled over.

Payday Chin 2004 Payday Loans: The Case for Many payday lenders fail to comply with Truth in Lending Act requirements by posting APR on charts or Federal Legislation brochures or disclosing it upon request. Free market mechanisms may fail to provide enough protection to consumers because instead of lowering lending rates at competing payday lenders, rates have increased. A potential policy solution is a federal interest rate cap to help structure the relationships between lenders and borrowers.

Credit Cards Cohen-Cole, & 2010 Your House or Your Credit Card, Starting with a sample of individuals with no delinquencies in 2006, results indicate the number of people Morse Which Would You Choose? choosing to become delinquent on mortgages while paying on their credit cards increased by 127 percent Personal Delinquency Tradeoffs between June of 2006 and December of 2007. The individual decision to choose to pay off credit cards and Precautionary Liquidity instead of the mortgage may be related to higher rates of foreclosure. Motives

Non- Conlin 1999 Peer Group Micro-lending The use of peer groups in micro-lending programs reduces overhead costs by enabling fixed costs such as traditional Programs in Canada and the training and business plans to deter bad entrepreneurs from participating in the program. Peer pressure from Loans United States participating in the program with friends or families may also encourage people to stick with the program.

Refund Duflo, Gale, 2006 Saving Incentives for Low-and Participants were offered a product that allowed individuals to make IRA contributions when they prepared Anticipation Liebman, Middle-income Families: Evidence taxes at different match levels: zero, 20 percent or 50 percent. Take-up rates for the IRA product were 3 Loans Orszag, & Saez from a Field Experiment with H&R percent (control), 8 percent (20 percent), and 14 percent (50 percent). Conditional on take-up, average Block contribution levels (excluding the match) were $765, $1,100, and $1,110, respectively. With the match included, average IRA deposits were $765, $1,280, and $1,590 respectively, among contributors. Tax preparer professionals appeared to play an important role in whether or not individuals participated in the IRA product.

Payday Elliehausen & 2001 Payday Advance Credit in Almost three-fourths of payday advance customers were turned down by a creditor or not given as much Lawrence America: An Analysis of Customer credit as applied for in the last five years. Two-thirds of customers considered applying for credit but changed Demand their mind because they thought they would be turned down. Payday lending customers were less likely than the adult population to have a bank or credit card. Of the 56.5 percent of customers having bank cards, over half refrained from using such cards in the last year because they would have exceeded their credit limit. Result indicate that most customers of payday lenders use this credit as a short term financing resource and are aware of the high cost of credit, but lack alternative credit sources.

Center for Financial Security 30

Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

General Feigenbaum 2008 Information Shocks and When shocks like medical expenses are placed closer to the end of life, it can magnify the effect of those Precautionary Saving medical expenses. If an individual receives information about likely medical expenses that will occur at the end of his or her life, this information will have a significant impact on precautionary savings and consumption over the lifecycle.

Lifecycle Fellowes & 2008 Banking on Wealth: America's New About 12 million U.S. households lack a checking account. There are over 26,000 non-bank businesses that Mabanta Retail Banking Infrastructure and provide check-cashing services, almost 23,000 payday lenders, and almost 10,400 pawnshops. About 90 Its Wealth-building Potential percent of high-cost financial service providers are located within one mile of a bank or credit union branch and 78 percent of these providers do business in the same neighborhood or census tract as a bank or credit union. The paper considers a number of possible scenarios if a non-bank financial services customer were to invest fees in the stock market or savings bonds.

Auto Title Feltner 2007 Debt Detour: The Automobile Title In 2005, 63 auto title loan companies with 260 locations were operating throughout Illinois state. The median Loans Lending Industry in Illinois loan principal was $1500, with an average finance charge of just over $1500. The average term for the loan is 209 days and average APR is 256 percent. Typically, cars used as collateral for auto title loans were about 11 years old with an average odometer reading of above 90,000 miles.

General Femminis 2001 Risk-sharing and Growth: The Role An increase in precautionary savings makes labor more productive in the goods sector. But in education, an of Precautionary Savings in the increase in precautionary savings draws resources away from investment in human capital. "Education" Model

Prepaid Fine, Leimbach, 2006 Distributing Prepaid Cards through A survey of 480 immigrant workers by the Center for Community Change and Community Financial Debit & Jacob Worker Centers: A Gateway to Resources found the median annual income of workers to be about $15,600, but the monthly saving to be Asset Building for Low-income about $289 per month. Close to half of respondents were unbanked, though many possessed requisite Households identification to open a standard bank account. About 82 percent of the unbanked expressed interest in obtaining a savings account. Additionally, 31 percent said they were interested in getting a credit card, 26 percent wanted a checking account, and 26 percent said they were interested in obtaining a home loan. Prepaid debit cards maybe a financial product to assist the immigrant worker community.

Refund First Nations 2009 Borrowed Time: Use of Refund Native population counties are compared with non-native population counties in 10 states to review the use of Anticipation Development Anticipation Loans Among EITC refund anticipation loans among Earned Income Tax Credit (EITC) recipients. There is a moderate to strong Loans Institute Filers in Native American positive correlation between an increase in the share of Native Americans in a county and the use of RALs Communities among EITC tax filers. EITC recipients pay an average of $250 for tax preparation and a RAL.

Payday Flannery & 2005 Payday Lending: Do the Costs Loan renewals or loans from frequent borrowers are not more profitable than other loans per se, although they Samolyk Justify the Price? certainly contribute to a store’s loan volume. Controlling for loan volume, results indicate that economic and demographic conditions in the neighborhoods where stores are located do not have much of an effect on profitability, although they do slightly influence default losses.

Auto Title Fox & Guy 2005 Driven into Debt: CFA Car Title Fox and Guy examine title lending practices across the U.S. They use data from a survey collected by the Loans Loan Store and Online Survey Consumer Federation of America. The survey collected in 11 states from 81 car title lenders and also surveyed 17 online title lenders. They found that the average APR charged was 300 percent in stores and could be as high as 650 percent for online lenders.

Center for Financial Security 31

Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

Lifecycle Grant 2007 Estimating Credit Constraints Sixty-eight percent of survey respondents hold at least some debt, with the mean level of about $3,900 per among US Households household. About 31 percent of consumers are credit-constrained; single households headed by men are much less likely to be constrained than those headed by single women. The incidence of credit constrained households is higher among middle income and college education households, but the degree to which these constraints reduce borrowing is also larger. Poorer households might not want to borrow as much as other constrained households but the marginal utility of an extra amount to someone earning less is higher than money lent to someone earning more.

Payday Graves 2003 Landscapes of Predation, Payday lenders tend to locate in poorer neighborhoods with higher minority concentrations than the county as Landscapes of Neglect: A Location a whole. There is a locational bias among banks; they tend to be located in wealthier and whiter Analysis of Payday Lenders and neighborhoods than the county as a whole. These results are strongest in counties with populations greater Banks than 250,000 people.

Credit Cards Gross & 2002 Do Liquidity Constraints and About 2/3 of households in the survey have a credit card and of those households, 56 percent are considered Souleles Interest Rates Matter for liquidity constrained. Increases in credit limits generate an immediate and significant rise in debt. The marginal Consumer Behavior? Evidence propensity to consume is much larger for people who begin near their credit limit. This behavior is consistent from Credit Card Data with the buffer-stock theory of precautionary savings.

General Guiso, Jappelli, 1992 Earnings Uncertainty and The impact of uncertainty in a household on that household's consumption is small. Precautionary saving & Terlizzese Precautionary Saving decreases when the ratio of total household resources to permanent earnings increases.

Life Gutter & Hatcher 2008 Racial Differences in the Demand Survey of Consumer Finances data from 2004 is used to examine the proportion of households with life Insurance for Life Insurance insurance policies and how much insurance is purchased. Whites had higher levels of net worth, more homeownership and greater usage of life insurance. Whites have more term insurance but there was not a significant difference between whites and blacks having whole life policies. Whites had a greater proportion of “human capital” insured; 40 percent compared to 18 percent for blacks.

Unbanked Herrmann & 2008 A Fundamental Need: Small- In response to concerns over the growth in payday loans, the FDIC launched a pilot program with 30 financial Tescher Dollar, Short-Term Credit institutions that provided incentives to offer small-dollar and short-term loans. There is discussion of small- dollar short-term credit alternatives including salary advance products offered by credit unions in Pennsylvania, Ohio and North Carolina and banks like Wells Fargo, U.S. Bank, and Mitchell Bank in Milwaukee. There is also an examination of microfinance organizations targeting Latino consumers in the mid- Atlantic states.

General Hurst, Lusardi, 2010 The Importance of Business As much as 50 percent of the total wealth in the pooled sample is explained by precautionary savings, but Kennickell, & Owners in Assessing the Size of within each group precautionary savings explains less than 10 percent of total household wealth. Business Torralba Precautionary Savings owners have higher than average wealth, but also face higher income risk than other households. Future research should consider excluding business owners from the samples.

Center for Financial Security 32

Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

Unbanked Joassart- 2010 Immigrant Banking and Financial As the proportion of minorities increases in tracts where foreign-born households live, accessibility to banks Marcelli, & Exclusion in Greater Boston and ATMS decreases rapidly. Immigrants do not have lower access to credit unions even when associated Stephens with racial and ethnic minorities. Canadian and Chinese immigrants tend to have greater access to traditional banks, but less access to check cashers and pawnshops. In contrast, Salvadorans, Haitians and Vietnamese may not have strong associations with traditional banks, but experience far greater access to alternative financial institutions.

Pawnshops Johnson & 1998 Pawnbroking in the US: A Profile of Pawnbroker customers had lower average incomes than the general U.S. population and were also less likely Johnson Customers to own a home. Only 57.6 percent of pawnshop customers had a checking account. Customers cited major reasons for borrowing: pressing bills (32 percent), personal reasons (32 percent), and car expenses (13.5 percent). Forty-five percent of active borrowers had borrowed once or twice in the last 12 months.

General Kimball 1989 Precautionary Saving in the Small The precautionary saving motive is risk aversion of the negative of marginal utility. Since uncertainty is and in the Large present in almost all aspects of life, the theory of choice under uncertainty is likely to become an even more important part of economics in the future. Although it will not answer every question about choice under uncertainty, the close analogy between risk aversion and the sensitivity of optimal choices to risk may be fruitful in illuminating precautionary saving and many other responses to risk.

General Karlan, 2010 Getting to the Top of Mind: How Reminder messages can induce individuals to set aside money for upcoming lumpy expenses and help McConnell, Reminders Increase Saving increase incremental savings and long-run smoothing of consumption. Individuals in Bolivia, Peru and the Mullainathan, & Philippines opened savings accounts with various incentives or commitment features designed to help people Zinman meet a savings goal. Sending periodic reminders via text message or letter increased participants’ likelihood of reaching their savings goal by 3 percent and the total amount saved by 6 percent.

Lifecycle Laitner 2004 Precautionary Saving Over the Precautionary savings are related to life-cycle saving for retirement. Later in life earning are strongly positively Lifecycle correlated with initial earnings but they have a higher variance. Further, precautionary savings adds about 5 to 6 percent to aggregate lifecycle wealth accumulation.

General LeBoeuf & Shafir 2009 Anchoring on the" Here" and Anchoring occurs when the framing and ordering of questions can impact how individuals respond, estimate, "Now" in Time and Distance and behave. People underestimate future dates or times based on their current status. Prior research Judgments indicates that people's estimates of past and future time intervals are biased in a number of ways. People have a tendency to perceive past events as having occurred more recently than those events actually did. Additionally, people tend to be overly optimistic about the amount of time required to complete a task.

Life Liebenberg, 2010 The Demand for Life Insurance Survey of Consumer Finances data is sued to examine life insurance policy loan demand. There is a Insurance Carson, & Hoyt Policy Loans significantly positive relationship between loan demand and recent expense or income shocks. Life insurance policy loans increased dramatically in the late 1960s when market interest rates were greater than policy loan rates. Panel data from 1983-1989, suggests that when households need emergency funds, alternative funds like policy loans become more of an option. After households experienced expense or income shocks, there is an increase in use of policy loans. Credit scores may be helpful in predicting loan demand.

Center for Financial Security 33

Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

Payday Logan & Weller 2009 Who Borrows From Payday The average age of the head of households who took out a payday loan was 39 and about 41 percent of Lenders? An Analysis of Newly families that took out a payday loan were headed by single women. Of those in the survey, 34 percent of Available Data payday borrowers cited convenience as the reason for borrowing from a payday lender. About 29 percent said that the reason they borrowed was for an emergency, 21 percent cited a basic consumption need such as paying for gas or a car repair, and 8 percent said that a payday loan was the only available option.

General Lusardi 1998 On the Importance of the Health and Retirement Study (HRS) data is used to examine how households might save to insure against Precautionary Saving Motive uncertain events including income shocks. In order to estimate a precautionary saving model one needs information about wealth, household characteristics (including permanent income), and income risk. People who face higher income risk save more and accumulate more wealth but the contribution of precautionary saving to wealth accumulation is not particularly large--between 1 and 3.5 percent.

General Lusardi, 2011 Financially Fragile Households: The 2009 TNS Global Economic Crisis survey is used to examine household financial fragility in the U.S. Over Schneider, & Evidence and Implications half of the survey respondents said that they would be unable to come up with $2,000 in 30 days: 24.9 Tufano percent reported being certainly able to cope, 25.1 percent probably able to cope, 22.2 percent probably unable to cope, and 27.9 percent certainly unable to cope. Individuals with less income and education were less able to cope, but almost a quarter of households making between $100,000 and $150,000 said they would not be able to raise $2,000 in 30 days. Women were less likely than men to be able to cope with the financial shock. African Americans and Hispanics reported that they were less likely to be able to deal with the financial shock. Further, families with children or caring for aged parents were also less likely to be able to cope with the financial shock. The most commonly cited mechanisms for coping included drawing from savings (62 percent), relying on family and friends (34 percent), mainstream credit such as a credit card (31 percent), selling possessions (19 percent), or increasing working hours or getting another job (23 percent).

Lifecycle Lyons 2003 How Credit Access has Changed Survey of Consumer Finances (SCF) data is used to investigate the degree to which household liquidity Over Time for US Households constraints relaxed between 1983 and 1998. The gap between actual and desired borrowing is estimated. The ability of all households to obtain their desired debt levels increased after 1983 and most dramatically between 1992 and 1998. The findings hold true across all households regardless of permanent earnings, age, gender, or race. Those experiencing the greatest gains in credit access were black households and households with low permanent earnings.

Lifecycle Maki & Palumbo 2001 Disentangling the Wealth Effect: A Data from the Survey of Consumer Finances and Flow of Funds Accounts is used to review the impact of Cohort Analysis of Household wealth accumulation on household saving rates in the 1990s. Among households or families who gained the Saving in the 1990s most during the stock market boom of the later 1990s, the families decreased their net saving rate sharply from 1995 to 2000. The growing rate of decline in personal savings for U.S. families may be explained by those families consuming outside their current level because of the large growth in their stock portfolios.

Center for Financial Security 34

Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

Non- Mansuri 2007 Credit Layering in Informal In less developed countries, informal lenders with access to markets or capital often find it attractive to traditional Financial Markets delegate loan provision to downstream lenders who have an information or enforcement advantage in dealing Loans with particular borrowers. This is credit layering. Lenders have a relative advantage in lending to tenant farmers. Landlords can, by virtue of their ownership of tenanted land, observe output more accurately and at a lower cost. In contrast, traders have access to capital on preferential terms but cannot observe tenant output without undertaking a costly audit. Credit layering dominates direct competition in loan contracts only when tenants are sufficiently poor.

Payday Manturuk & 2007 North Carolina Consumers after Payday lending was outlawed in North Carolina in 2006. Three out of 5 respondents did not know that payday Quercia Payday Lending: Attitudes and lending was illegal in North Carolina, though 60 percent of former payday borrowers knew that there was a Experiences with Credit Options ban. Over 75 percent of households said that the elimination of payday lending had no impact on their household. Of families that had been payday borrowers, 68 percent said that the elimination had no impact on their household. The majority of consumers who participated in the focus group reported that they initially took out a payday loan because of a financial shock and some frequent borrowers viewed payday loans as a kind of supplemental income.

Refund Masken, Mazur, 2001 Do Products Offering Expedited Use of refund anticipation loans (RALs) has increased over last several years. From tax year 2001 to tax year Anticipation Meikle, & Nord Refunds Increase Income Tax 2005, the number of returns using RAL products grew from 15 million to about 20 million. Taxpayers who Loans Non-Compliance? used RAL products were more noncompliant tax payers. RAL users are 27 percent to 36 percent more noncompliant than taxpayers who do not use a bank product. However, results do not show a causal relationship between using an RAL and noncompliance.

Payday McKernan, 2010 Prohibitions, Price Caps, and One third of low-income families without savings accounts report that they would use a payday lender or pawn Ratcliffe, & Disclosures: A Look at State something to pay a large bill in an emergency. Customers of these products have few alternatives. Kuehn Policies and Alternatives Financial Pawnshopss are used most often (13 percent) and auto title loans and refund anticipation loans (RAL) are Product Use used least often (6 percent). Pawnshop and rent-to own customers tend to have the lowest incomes, while auto title customers have higher incomes. About 90 percent of auto title and payday customers report having a bank account, while roughly 80 percent of pawnshop, RAL, and rent-to-own customers are banked. Auto title and payday customers have higher levels of education than do users of the other three products.

General Merrigan & 1996 Precautionary Saving Motives: An Data from the U.K. Family Expenditure Survey is used to examine precautionary savings motives. Greater Normandin Assessment from UK Time Series income uncertainty leads to larger current saving, as predicted by precautionary saving behavior. Households of Cross-sections which are less likely to face liquidity constraints or to share risks are more sensitive to income uncertainty. Households where the main income earner works in manufacturing are more likely to self-insure against income uncertainty, but the occupation of main earners does not significantly alter precautionary saving behavior.

Lifecycle Meyer & Sullivan 2003 Measuring the Well-being of the Consumer Expenditure Survey, Panel Study of Income Dynamics, and Current Population Survey (CPS) is Poor Using Income and used to explore consumption and income measures for low-income individuals. The poorest single mother Consumption families have extremely low levels of income, expenditures and consumption. For example, a CPS family at the 10th percentile has an annual total income of $5,098 (or $425 per month). More than 1 percent of all low- educated single mother headed families in the CPS have zero or negative annual total income. These lowest income families appear to spend and consume more than their total income.

Center for Financial Security 35

Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

General Mullainathan & 2009 Savings Policy and Low and moderate income families lack financial slack. In a financially difficult situation, a wealthier person Shafir Decisionmaking in Low-Income can often cut back on extra expenses, but a poor person must cut back on essential expenses. If a wealthier Households person and a poorer person face equal value financial shocks and cut back the same amount on consumption, the wealthier person is cutting back on their lower marginal utility consumption.

General Nocetti & Smith 2010 Uncertainty, the Demand for Demand for medical care is related to precautionary saving. Uncertainty is a key component in the demand for Health Care, and Precautionary health care goods and services. Consumers save extra when faced with uncertainty surrounding the incidence Saving of illness, making health uncertainty equivalent to income uncertainty. If savings increase, consumers reduce the demand for medical care when young. However, in the presence of uncertainty surrounding medical treatments of preventable diseases (e.g. diabetes, cervical cancer, influenza, hepatitis), consumers purchase additional (preventive) care when young as a form of self-insurance. Given this insurance, consumer’s welfare may increase with the degree of uncertainty over medical care effectiveness.

General Parker 2000 Spendthrift in America? On Two As the elderly have become an increasing share of the population, they may have pushed the aggregate Decades of Decline in the US saving rate down because the elderly consume a larger fraction of their incomes than other age groups. The Saving Rate cohorts that are higher consumers may move to the ages at which their consumption and incomes are higher and so push up the aggregate consumption rate. Lower-consumption cohorts may also die and be replaced by higher-consumption cohorts. The estimated relationship between consumption and wealth is not linear, in that the cluster of low-wealth households has more consumption than would be implied by the relationship between wealth and consumption for higher-wealth households.

Non- Pickering & 2001 Cultural Aspects of Credit The Lakota Fund was created in 1986 to make small, uncollateralized loans on the Pine Ridge Reservation in Traditional Mushinski Institutions: Transplanting the South Dakota but terminated its initial program due to low repayment rates. Social and cultural factors Loans Grameen Bank Credit Group prevented the model from being successfully implemented on Pine Ridge. Family units could be important for Structure to the Pine Ridge Indian replicating micro-finance models and that on Pine Ridge; the peer pressure from the credit-group structure put Reservation too much pressure on individuals.

Auto Title Pindus, Kuehn, 2010 State Restrictions on Small-Dollar There are several types of common restrictions at the state level on various small dollar loan products. Auto Loans & Brash Loans and Financial Services, title loans are prohibited in 27 states and 13 states have an APR cap. Forty states have a monthly interest rate 2005-2009: Summary, cap for pawnshops and 10 states have a return requirement. Payday loans are prohibited in 13 states and 33 Documentation, and Appendix states have an APR cap. There are also 33 states with a maximum loan amount, 35 states have a minimum or maximum lending period, and 34 states have a fee disclosure requirement. There are 3 states with APR caps for refund anticipation loans. Seventeen states have disclosure requirements and 2 states have a right to rescind.

Pawnshops Prager 2009 Determinants of the Locations of Payday lenders are more prevalent in both urban and rural counties where a larger share of the population is Payday Lenders, Pawnshops and below the age of 40 and less prevalent in both urban and rural counties where a larger share of the population Check-cashing Outlets lives below the poverty level. The number of payday loan stores per million capita is significantly related to the share of the population with a high school diploma.

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Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

Lifecycle Ryan et al. 2009 FDIC: National Survey of An estimated 7.7 percent of U.S. households, approximately 9 million, are unbanked. At least 17 million adults Unbanked and Underbanked reside in these unbanked households. The proportion of households that are unbanked varies considerably Households among different racial and ethnic groups, with certain racial and ethnic minorities more likely to be unbanked than the population as a whole. Minorities more likely to be unbanked include blacks (21.7 percent of black households are unbanked), Hispanics (19.3 percent), and American Indian/Alaskans (15.6 percent). Racial groups less likely to be unbanked are Asians (3.5 percent) and whites (3.3 percent). Nearly 20 percent of lower income households, almost 7 million, do not currently have a bank account. Households with earnings below $30,000 account for at least 71 percent of unbanked households. An estimated 17.9 percent of households, roughly 21 million, have accounts but are underbanked.

Individual Sanders 2010 Savings Outcomes of an IDA Survivors of domestic violence were enrolled in an IDA program. About two-thirds of women reached their Development Program for Survivors of Domestic savings goal and 76 percent made at least one matched withdrawal purchase. On average, women saved $87 Accounts Violence per month while living on modest incomes (most women lived at or below 150 percent of poverty). These savings outcomes demonstrate that women impacted by intimate partner violence are capable of successfully saving in an IDA program when given the opportunity.

Payday Schneider 2009 One Size Does Not Fit All: A Interviews with 22 prepaid cardholders in the Chicago and Seattle metro areas indicated that prepaid cards Comparison of Monthly Financial are used for direct deposit of paychecks. Participants most commonly used money orders or prepaid cards to Services Spending pay bills. Further in-depth analysis of three survey participants examined the average cost of using a prepaid card, check cashing service, or a traditional checking account. Person A's average monthly fees were $36.83 for a prepaid card, $55.95 for check cashing, or $23.90 for a checking account. Person B's average monthly fees were $26.98 for a prepaid card, $45.60 for checking cashing, or $32.43 for a checking account. Person C's average monthly fees were $14.95 for a prepaid card, $29.80 for check cashing, and $21.31 for a checking account.

Payday Schneider & 2010 How Should We Serve the Short- Low-income people with short-term credit needs borrowed in two distinct patterns. One group generally Koide Term Credit Needs of Low-Income borrowed once per year for larger amounts, with 83 percent borrowing over $1,000. The top reason for Consumers? borrowing was to purchase a car or truck. The other group of frequent borrowers generally borrowed smaller amounts, between $100 and $1,000, two to four times a year. This group relies on a wide array of debt products, including personal loans (51 percent), lines of credit (39 percent), and cash advances on credit cards (37 percent). Over a third of this group (36 percent) borrows from family and friends. They borrow to pay for utilities (32 percent), home repairs (31 percent), basic living expenses (22 percent), repayment of other debt (21 percent), or medical bills (17 percent). Alternative loan types include salary advance, depositories, installment lending and workplace lending.

Individual Sherraden, 2003 Income, Institutions, and Saving The income and amount of money put into their IDAs was examined for participants in the American Dream Development Schreiner, & Performance in Individual Demonstration project. As individual participant's incomes increased, their savings rate decreased. For each Accounts Beverly Development Accounts $100 of recurring monthly income, up to $799, the savings rate decreased at a rate of 0.01 percentage points. But for each $100 of recurring monthly income over $800, the savings rate decreased at a rate of 0.69 percentage points. IDA contributions increased as participants received financial education, but only up to 12 hours of education. After that, there was not a clear pattern in the data. Participants in the project saved about the same amount, regardless of income level, and as income increased, the savings rate decreased.

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Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

Individual Sherraden & 1991 Assets and the Poor: A New Asset accumulation is examined as a source of economic and social development for families. Development Sherraden American Welfare Policy Accounts

Individual Sherraden, 2010 Striving to Save: Creating Policies Qualitative research of families involved in an IDA program that included financial education and survey data Development McBride, & for Financial Security of Low- explores saving behaviors in low-income families. Accounts Beverly income Families

Payday Skiba & 2008 Do Payday Loans Cause Administrative records on payday loans from 145,000 individuals obtained from a financial service provider Tobacman Bankruptcy? were compared against filings for Chapter 7 or 13 bankruptcies from four U.S. Bankruptcy Courts in Texas. The matched data sets indicated that 8,331 of the 145,519 payday loan applicants filed for bankruptcy, a rate of filing that is 6 times the average rate in the population. Approval of a single loan application initiates a pattern of subsequent borrowing from the lender. The estimated effect of getting a payday loan is to increase the change of filing for Chapter 13 bankruptcy by 2.48 percentage points.

General Skinner 1988 Risky Income, Life-Cycle In the model, precautionary savings are very small with moderate levels of income uncertainty. Precautionary Consumption, and Precautionary savings often depend on the proportion of lifetime resources at risk. It is only to the extent that annual Savings variations in earning signal a permanent change in future earnings that precautionary savings become important. The Consumer Expenditure Survey from 1972-1973 is used to examine how different occupations might impact precautionary savings. Individuals in traditionally riskier occupations including sales and self- employment saved significantly less than the average.

Credit Cards Soman & 2002 The Effect of Credit on Spending Credit limits impact the propensity to spend, but only when the credibility was high. Credit limit influences Cheema Decisions: The Role of the Credit expectation of future earnings potential. Credit limit also influences spending to a greater extent for consumers Limit and Credibility with lower credibility, younger consumers, and less-educated consumers.

Lifecycle Souleles 2004 Expectations, Heterogeneous Data from the Michigan Survey of Consumer Attitudes and Behavior is used to test the extent to which Forecast Errors, and Consumption: consumer expectations are rational and the extent to which those expectations are useful to forecast Micro Evidence from the Michigan household spending. Households were asked to assess how their family is doing financially compared to the Consumer Sentiment Surveys previous year; if they would be better or worse off in one year; if business conditions in the country would be good or bad in one year and in five years; and if they thought it was a good or bad time for large durable goods purchases.

Pensions Sourdin 2008 Pension Contributions as a The use of pension contributions is examined as commitment devices for savings. Problems of self-control Commitment Device: Evidence of positively affect the probability of investing in illiquid assets such as superannuation (a company pension Sophistication among Time- plan). On average, sophisticated households with self-control problems are less likely to hold assets in a very inconsistent Households liquid form such as bank deposits and stocks.

Credit Cards Stango & 2009 Fuzzy Math, Disclosure Regulation Consumers have biased perceptions of borrowing costs. Mandated APR disclosure can alter lenders' ability to Zinman and Credit Market Outcomes: take advantage of this bias. Evidence from Truth in Lending Reform

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Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

Auto Title Tennessee 2010 The 2010 Report on the Title In 2008, over 161,000 new consumer title agreements generated over $103,000 in loan volume in Loans Department of Pledge Industry Tennessee. Of new agreements, 86 percent were for $1000 or less and 60 percent were for $500 or less. Financial The maximum loan amount permitted in Tennessee is $2500; the maximum APR is 264 percent. The Institutions Department found there was a 16 percent increase in new title pledge agreements from 2006 to 2008.

Refund Theodos, Brash, 2010 Characteristics of Users of Refund The most important characteristics influencing RAL use were lower income, young adulthood, single head of Anticipation Compton, Anticipation Loans and Refund household filing status, receipt of the EITC, and use of a paid preparer. RAL products are used by one in Loans Masken, Pindus, Anticipation Checks seven tax filers and more than one in six filers who receive refunds. There is heavy use of RAL products in the & Steuerle southern U.S. and on Indian reservations in the Midwest and Great Plains. Qualitative interviews with industry representatives indicated reasons for using RAL products included: needing money to alleviate a post-holiday financial strain, general financial strain and unexpected expenses, lack of funds for tax preparation costs, lack of a bank account, mistrust of conventional financial institutions, and being a military family.

General Thibos 2010 Risky Business: Risk Management Eight major types of risks are identified as being especially important to low and moderate income family Tools & Products for Low-to- financial stability. Major types of risk are income shocks, permanent reductions in earning power, Moderate Income Families retirement/end of life, expense shocks, property loss/damage, natural disasters, mobility enhancing, and finance related. Coping strategies are categorized into three main areas: savings, credit or economizing. The difference between the strategies is when the family spends less money. In order to utilize savings the family has had to spend less before the financial risk; to utilize credit a family has to spend less after the risk event in order to pay for the debt; to economize a family must spend less during the risk event to "absorb the expenses or income loss."

Refund Treasury 2008 Many Taxpayers Who Obtain A survey of IRS data found that 52 percent of RAL users reported they received loans the same day or within Anticipation Inspector Refund Anticipation Loans Could two business days of the tax return preparation. About 85 percent reported their tax preparer made it clear Loans General for Tax Benefit from Free Tax Preparation that they were receiving a loan; 88 percent reported the preparer explained the fees; but only 34 percent Administration Services reported that the interest rates for the RAL were explained. When asked why they obtained the RAL: 85 percent said that they wanted faster access to their tax refund, 74 percent used the money to pay bills, 14 percent used the money to buy or repair a car or for home repairs and expenses, and 8 percent said that they put the money in savings. Sixty-four percent of the individuals taking RALs had a checking or savings account.

General Van Veldhoven 1993 Exploring Saving Behaviour: A A general model of saving behavior identifies eight major “blocks” that impact savings behavior. These are & Groenland Framework and a Research socioeconomic context (economic climate, information, personal economic situation and institutional Agenda structure); events and stimuli (income, personal, or market events); perceptions, cognitions and evaluations (framing, cognitive variables, sentiments including perceived risk, uncertainty, optimism); financial planning and saving antecedents (time orientation, gratification orientation, goals); saving motives (precaution, wealth, future consumption and investment); allocative saving acts; discretionary saving acts; and saving outcomes (institutional, money, securities).

General Wang 2009 Optimal Consumption and Asset Consumption and saving are impacted by changes in income. Higher income volatility is related to learning Allocation with Unknown Income about managing risk of income loss with savings. Growth

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Appendix A: Summary of Literature

Mechanism Author Year Paper Title Main Findings/Contribution

Payday Washington 2006 The Impact of Banking and Fringe An exploration of why low-income American consumers are unbanked and the impact of various pieces of Banking Regulation on the Number regulation on unbanked individuals. In 2000, 37 percent of these households had no savings or checking of Unbanked Americans account. Price caps on maximum fees for a check conversion cause a 4 to 5 percentage point increase in the likelihood that a low-income minority household will establish a bank account.

General Wilson 1998 The Aggregate Existence of U.S. Department of Commerce data on nondurable expenditures, durable expenditures and after-tax labor Precautionary Saving: Time-series income from 1954 to 1993 is used to examine if precautionary saving motives are significant in the aggregate. Evidence from Expenditures on When 15 percent of quarterly income is at risk, precautionary savings ranges from 5 to 10 percent of total Nondurable and Durable Goods saving. When 30 percent of quarterly income is at risk, precautionary savings ranges from 9 to 21 percent of total saving.

Payday Wilson, Findlay, 2010 An Experimental Analysis of the Experiments with students indicate that because payday loans are an option, all else constant, the probability Meehan, Demand for Payday Loans of financial survival (being able to pay all of the bills) is increased by 31 percent. Some participants did put Wellford, & themselves at financial risk because they took out payday loans, but most participants were benefited by their Schurter existence.

Refund Wu & Fox 2009 Big Business, Big Bucks: Quickie Examination of the use of refund anticipation loans (RALs) and the RAL industry indicate that consumers paid Anticipation Tax Loans Generate Profits for about $833 million in RAL fees in 2007 and that APRs charged can range from 50 to 500 percent. Loans Banks and Tax Preparers While Putting Low-Income Taxpayers At Risk General Zeldes 1989 Optimal Consumption with Risk-averse people save more relative to what is predicted by the permanent income hypothesis benchmark. Stochastic Income: Deviations It might be fitting to reconsider what an appropriate benchmark is for individuals with low levels of wealth. This from Certainty Equivalence is particularly important in dealing with three key consumption puzzles: excess sensitivity of consumption to transitory income, high growth of consumption in the presence of a low risk-free interest rate, and the high savings rate of the elderly.

Lifecycle Zhan & 2003 Assets, Expectations, and There is a positive association of a mother's assets with the mother's expectations of her child's education Sherraden Children's Educational achievement and the child's educational outcomes. Controlling for expectations, the relationships between the Achievement in Female-headed mother's assets and the child's educational outcomes are statistically significant. Savings are related to the Households probability of child’s high school graduation, and home ownership is related to child’s academic performance.

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